Armstrong World Industries Inc (AWI) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Armstrong World Industries, Inc. Q2 2013 earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's conference call is being recorded. I'd now like to turn the conference over to your host, Mr. Tom Waters, Vice President, Treasury and Investor Relations. Please go ahead.

Thanks, Ellie. Good afternoon, everyone, and welcome. Please note that members of the media have been invited to listen to this call and the call is being broadcast live on our website at Armstrong.com. With me this afternoon are Matt Espe, our President and CEO; Tom Mangas, our CFO; Frank Ready, CEO of our Worldwide Floor Businesses; and Vic Grizzle, CEO of our Worldwide Ceiling Businesses. Hopefully, you have seen our press release this morning, and both the release and presentation Tom Mangas will reference during this call are posted on our website in the Investor Relations section.

In keeping with SEC requirements, I advise that during this call we will be making forward-looking statements that involve risks and uncertainties. Actual outcomes may differ materially from those expected or implied. For a more detailed discussion of the risks and uncertainties that may affect Armstrong, please review our SEC filings including the 10-Q filed this morning. Forward-looking statements speak only as of the date they are made. We undertake no obligation to update any forward-looking statements beyond what is required by applicable securities law.

In addition, our discussion of operating performance will include non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of these measures with the most directly comparable GAAP measures is included in the press release and in the appendix of the presentation. Both are available on our website. With that, I will turn the call over to Matt.

Thanks, Tom. Good afternoon, everyone, and thank you for participating in today's call. This past quarter marked the first year-on-year positive volume story for Armstrong since the second quarter of 2010. While 2010 growth was driven by emerging markets, this past quarter we experienced volume growth across all geographies. We also experienced volume growth in all three of our North American businesses for the first time since the first quarter of 2006. Signs of a modest recovery in the US commercial markets are starting to appear.

On our last call, I mentioned we had just begun shipments from our new ceiling plant and homogeneous flooring plant in China. Ninety days into active production, I'm happy to report that orders, product acceptance, and manufacturing costs are all as anticipated. I look forward to the heterogeneous flooring plan starting service in August.

Second quarter results on both top line and bottom line were in the middle of our guidance ranges. Sales for the quarter of $707 million were up 5% in 2012, with minimal year-on-year foreign exchange impact. Excluding the impact of the Patriot wood distribution business that we divested in 2012, sales in the second quarter of 2013 were up 6%. All of our regions experienced sales growth. Sales were up in North America, primarily driven by home builder demand for wood flooring, but we also saw improvements in commercial ceilings and flooring. European sales were up in the quarter, though the ceilings business did benefit from a relatively easy year-on-year comparison. Pacific Rim sales were up despite continued weakness in Australia. We were pleased with our sales performance in ABP Americas but we missed our expectations in our businesses in Europe.

Adjusted EBITDA was $98 million. EBITDA was down as expected by $12 million from 2012, driven by lumber inflation and wood manufacturing costs, the production and SG&A expenses associated with our three plant start-ups in China, and the lower non-cash pension credit. Both Ceilings and Resilient Flooring saw profitability improve in the Americas, but Europe and Pacific Rim are down. Year-to-date sales of $1.329 million were up 1% from 2012 with minimal foreign exchange impact. Again, if we exclude the 2012 impact of the Patriot business, our sales were up about 3%. Adjusted EBITDA for the first half of 2013 was $177 million, down $17 million from 2012, and as with the quarter, wood costs, plant start-up expenses, and the pension credit were the drivers of the decline.

The Wood business remained a challenge for us in the second quarter. Before reviewing segment results, let me update you on that situation. Now, when we talked to you about our first quarter results, we noted that the Wood business was facing several headwinds. Number one, the need to add capacity by on-boarding 400 new production employees at our solid wood plant; number two, the availability of green lumber; number three, costs and manufacturing productivity issues driven by the purchases of kiln-dried lumber; and number four, pricing actions lagging lumber inflation. At that time, we anticipated that manufacturing productivity improvements and changes in the price versus inflation dynamic would allow us to get our service rates and profitability back to expected levels by the third quarter. However, as the quarter unfolded it became apparent that while we were making progress on all four issues, the pace of change in some areas was slower than we anticipated.

I want to spend a minute on each of the four areas to give you comfort that the improvements we're now seeing are real and sustainable. Number one, crew additions have moved forward but ramping up capacity and achieving desired productivity are behind plan. Now that said, the final crew has just started at our Beverly, West Virginia, facility and we'll be running at full capacity and effectiveness in all plants later in the second half and return service levels to our targeted full rates in the fourth quarter. Number two, purchases of green oak are up 10% in the second quarter, compared to the first quarter. As you know, kiln-dried lumber can cost between 30% to 50% more than green lumber, so having an appropriate amount of green lumber for us to dry in our yards is critical.

Number three, purchases of kiln-dried lumber have been steadily declining. By June, we were purchasing 50% less kiln-dried oak than in the first quarter. Improvements in this area are actually slightly ahead of plan. Reducing the use of kiln-dried versus green lumber not only lowers input costs but has a positive impact on manufacturing yields and product quality. Number four, green lumber costs continue to rise in the second quarter and increased beyond our expectations, but they appear to have plateaued in June. As you may have noticed, we recently announced an additional 5% to 7% price increase that took effect in mid-July.

Now, at this point in time, we have price increases scheduled and accepted by all members of our three key channels, builders, big box, and independent retailers. Sequential monthly price improvements in the second quarter give us confidence that we're now on track to close the price versus inflation gap by the fourth quarter. The delay in the wood recovery is disappointing but as I visited the plants in July, as I've reviewed recent price in lumber cost trends, I'm confident we've taken the necessary actions and are on top of the issues. Wood profitability will build momentum in the third quarter. We anticipate being ahead of last year by the fourth quarter.

Now, in the second quarter, the Wood business continued to see strong demand from home builders and a modest uptick in consumer buying. Sales of $138 million were up $13 million from 2012, and when adjusted for the Patriot divestiture, were up over $24 million. Despite our lumber procurement and productivity challenges, wood shipments were up in the high teens. Price was higher but we're still chasing lumber inflation and Tom Mangas will provide more details on lumber in a few moments. Adjusted EBITDA was down from 2012, driven by the headwinds just discussed.

Year-to-date wood sales are up 20% when excluding the Patriot sales from the base period, but profitability is down, again driven by the same factors that impacted the second quarter. Brazilian flooring sales were down slightly in the quarter. In the Americas, the small decline was driven by pricing mix as volume was up modestly. We experienced strength in commercial and residential vinyl products in the Americas, particularly luxury vinyl tile. But the laminate category faced tough year-on-year comparisons in the home center channel. European sales were up slightly driven by price gains while volume and mix were flat.

Within Europe, the markets were a mixed bag with strength in Central and Eastern Europe but continued weakness in Southern Europe, Benelux, and Scandinavia. Pacific Rim sales were down as Australia commercial declines persisted in the second quarter, but the trend was better than the first quarter. As expected, profitability in the Brazilian segment was down versus last year. Year-to-date Brazilian sales were down 3%, driven by lower volumes in all geographies. Profitability was lower due to sales declines in Europe and plant start-up costs in China. Profitability was up in the Americas despite lower volumes.

The Ceilings business experienced higher sales and profitability in the second quarter with all geographies growing sales. The sales gains were primarily volume-driven but mix and price also contributed. Much of the quarterly improvement was driven by the US commercial sector. We saw solid improvements in volume, price, and mix. Europe was up with strength in the UK and the Pacific Rim was up despite continued weakness in Australia. Ceilings profitability was up in the quarter, driven by sales gains, as well as manufacturing productivity which overcame the cost headwinds associated with our new ceilings plant in China and the plant construction project in Russia.

Year-to-date Building Products sales were up just over 1% despite lower sales in the first quarter. Profitability was also up on a year-to-date basis as second quarter gains more than offset year-on-year declines in the first quarter. Within the Ceilings segment, our global architectural specialties business experienced strong growth with sales up in the mid-teens versus 2012. All regions experienced sales growth with Europe leading the way, as several projects shipped in the quarter. For the year, this business has grown sales by more than 10% and continues to provide positive synergies for our core Ceilings business.

Finally, I'm pleased to announce we've just received Board approval to build a North American luxury vinyl tile plant. This $40 million investment will begin construction later this year, after we complete a site selection process. I've spoken about LVT in the past, citing the fast growth of this high-value category which is driven by the appealing visuals and superior performance and installation characteristics of the products. Now for the most part, we source and import these products today, but given current and projected volumes, manufacturing in the US is now a financially attractive option. Local production and the elimination of freight and duty expense will drive lower cost, reduce inventories, and provide better customer service and lead times. This is an exciting product category for us and an appealing investment in financial terms as well. This investment, along with our Millwood, West Virginia, mineral wool plant, the three plants in China, and the ceiling plant in Russia brings to six the number of significant new manufacturing investments we've initiated in the last three years and will further expand and improve our product category range.

So with that, I'll turn it over to Tom Mangas for a more detailed discussion of our financial performance and an update on guidance and the outlook for the quarter.

Thanks, Matt. Good afternoon to everyone on the call. In reviewing our second quarter results, I'll be referring to the slides available on our website starting with slide 4, key metrics, as Tom Waters already covered slide 2 and Slide 3 as simply an explanation regarding our standard basis of presentation.

Matt mentioned quarterly sales and EBITDA results, so I will only point out that adjusted operating income and adjusted EPS were also down versus last year by 17% and 15%, respectively. Second quarter free cash flow of $32 million was similar to the $36 million generated in the second quarter of 2012. I will address the drivers of EBITDA and free cash flow in more detail on upcoming slides. We closed the second quarter with net debt of $764 million, down from $878 million at the end of the second quarter of 2012. Almost all the change reflects our cash generation in the last 12 months, as debt is practically the same as 2012. Finally, our unadjusted return on invested capital, on a continuing operations basis, was 9.3%, an increase of 100 basis points over the prior year.

Slide 5 details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $31 million in the quarter. The $3 million cost reduction adjustments in this past quarter include $2 million associated with the closure of a WAVE plant in Spain and additional expenses associated with headcount reductions in our European and Australian businesses which we announced last quarter. In 2012, we had $8 million associated with the closure of our Mobile, Alabama, ceilings plant including some environmental charges and cost reduction actions in our European ceilings business. Interest expense was lower than in 2012, as we began to benefit from our March 2013 refinancing. Tax expense was slightly higher despite earnings being down year-on-year, primarily due to greater unbenefited foreign losses in 2013. This year-on-year increase in foreign losses is largely a result of the expenses in China and Russia associated with plant construction and start-up costs.

Moving to slide 6, this illustrates our sales and adjusted EBITDA by segment for the quarter. Brazilian flooring sales were flat. Volumes were up in North America low-single digits, driven by both residential and commercial LVT and other commercial products. Volumes were down in the Pacific Rim due to weakness in Australia. Sales in China were also down, but this was expected. Our customers in China adjusted to our change in service from import to local production and reduced their inventory levels to benefit from our shorter lead times. Overall for this segment, price and mix were essentially flat.

Adjusted EBITDA was down $2 million due to plant start-up costs, impacting Pacific Rim results and mix and production costs dragging in Europe. Profitability in the Americas was up double digits in the Resilient business, driven primarily by manufacturing productivity improvements, mix gains, and commercial products and lower SG&A. Wood flooring sales were up 11% and would have been up roughly 20% if not for the Patriot divestiture. Volume was in the high teens excluding the Patriot divestiture. Price was up, however, negative mix offset price as sales growth in the builder channel exceeded growth independent and big box customers. Matt detailed many of the factors driving lower adjusted EBITDA in the Wood segment, so I just wanted to point out that negative mix as anticipated was also a factor in the year-on-year profit decline.

One of the areas we've been getting a lot of questions on is lumber prices and there appears to be some confusion on the subject. Please turn ahead to slide 7 for a moment as I want to discuss this issue. This species of lumber we buy are hardwoods, primarily oak but also maple, hickory, ash, and others. The more common lumber discussed in the financial marketplace is framing lumber, materially 2X4s. This comes from soft wood species such as spruce, pine, and fir, and is more widely used than hardwoods. Framing lumbers futures trade on the Chicago Mercantile Exchange.

As you can see from the graph on slide 7, while these two types of lumber prices move with some positive correlation, there are different supply and demand characteristics for each. And sometimes, like now, price trends diverge. The Appalachian Green Oak that is our predominant input has been rising in price since early 2012 and accelerated meaningfully in the second half of last year. We now see green lumber prices stabilizing but at levels we've not experienced in more than a decade. This explains our many price increases in the past year and why our price realization is chasing inflation and our financial results in this quarter. As Matt mentioned, we do expect to recover our wood margins to their mid-2012 levels by the fourth quarter.

Turning back to slide 6, you can see that Building Product sales were up 7%. Global sales were driven by gains in volume, price, and mix. North America, Ceilings unit volumes increased low-single digits. Regionally, we saw particular strengthen the Northeast and we believe a good portion of that strength to be driven by Hurricane Sandy related repair activity. Europe, Middle East, and Africa saw sales increase despite little to no benefit from emerging markets. Matt mentioned strong sales in the UK this quarter.

You might recall in the first quarter, we highlighted the weaker start to the year in the UK which we attributed to an unusually strong Q1 of 2012. Similarly, we think this quarter's relative strength is again a base period issue, just now in our favor. Pacific Rim sales were up in the high-single digits despite declines in Australia. Adjusted EBITDA in Building Products increased $7 million versus the second quarter 2012, driven by sales, manufacturing productivity, and earnings growth from our WAVE joint venture. The corporate segment was down, driven by the decline in our domestic pension credit, higher foreign pension expenses, outside consulting services, and higher benefit costs.

Slide 8 shows the building blocks of adjusted EBITDA from the second quarter of 2012 to our current results. As you can see, mix and price were slightly down, as positive price was more than offset by mix in the Wood segment and in both European businesses. As Matt mentioned in his introductory comments, we are delighted to see growth from volume for the first time since the second quarter of 2010, now driven by modest growth in the developed world. Inflation was almost entirely due to lumber. The $3 million in manufacturing decline is the net of all of this Wood segment issues we have detailed which were partially offset by excellent progress in our North American Ceilings and Resilient Flooring facilities. The SG&A increase was driven by headwinds in corporate and emerging markets, partially offset by savings in the developed world business units. WAVE added $1 million to our year-on-year results. Finally, our non-cash pension credit is lower in 2013, as we mentioned in our guidance in February.

Turning now to slide 9, you can see our free cash flow for the quarter was very similar to 2012 in total. Cash earnings were lower than the prior year, driven by reduced earnings and a higher tax rate. Working capital was a use of just $1 million of free cash flow in the quarter, but that was improved from last year by $12 million with favorable inventories and payables offsetting higher receivables which are linked to our higher sales. Capital expenditures were lower than in 2012, due to the timing of equipment purchases for our emerging market plant builds. Cash interest expense decreased by $3 million as we realized the cash benefit of our March refinancing. WAVE contribution to cash was slightly negative. The remaining use of $12 million illustrated in the other bar relates to VAT payments on equipment purchases in China and the timing of environmental costs associated with the closure of our Mobile, Alabama, facility.

Beginning with slide 10, I'll begin discussing year-to-date results. As you can see, sales were up just over 1% and would have been up 3% if adjusted for the Patriot divestiture in 2012. Year-to-date sales growth came from North America. Europe was down, as was Pacific Rim due to Australia. Operating income, adjusted EBITDA, EPS, and free cash flow were all down year-to-date.

Slide 11 illustrates our sales and adjusted EBITDA by segment for the year-to-date period. Resilient Flooring sales were down 3% with the entire decline occurring in the first quarter. Volumes were down in all regions but global price and mix were up. EBITDA was down in the Pacific Rim and Europe, due to plant start-up costs and volume declines, respectively. As with the quarter, profitability in the Americas was up double digits year-to-date. The year-to-date improvement was driven by manufacturing productivity gains, better mix, much of it coming from the LBT category, as I mentioned before and lower SG&A overcoming lower year-to-date volumes. Wood flooring sales were up 10% and would have been up 20% if not for the Patriot divestiture. Year-to-date the Wood EBITDA story is the same as the second quarter, so I will not repeat myself here.

Building Product sales were up 2% through June. Sales were up in North America and Pacific Rim but down in Europe. Global mix and price gains, and volume growth in China and India more than offset volume declines in Europe, Australia, and North America. Adjusted EBITDA in the Building Products segment increased $9 million year-to-date. Price, manufacturing improvements in the US, and increased contributions from the WAVE joint venture more than offset volume declines and the emerging market expansion expenses. The corporate segment was down $11 million, driven by the same factor affecting the second quarter.

Slide 12 shows the building blocks of adjusted EBITDA. The only difference from the quarterly story is volume. Year-to-date we're still behind 2012, creating a drag on earnings. All of the other factors are essentially the same as the second quarter.

Slide 13 shows free cash flow for the year as a use of $19 million, similar to the $14 million used in 2012. However, the elements of the story are different. Cash earnings are lower and capital expense higher, driven by plant expansion capital spending. But these headwinds are overcome by working capital which improve, due to increased accounts payable. WAVE contribution to cash was slightly negative as they were able to squeeze more from their operational cash accounts in 2012, due to their then-newly available revolving credit facility.

Slide 14 updates our guidance for 2013. We are maintaining our top line guidance of $2.7 billion to $2.8 billion but as a result of the delay in wood, the Wood segment recovery and Europe, we are lowering our adjusted EBITDA and cash flow expectations for the year. Specifically, we now project full-year EBITDA to be $370 million to $400 million. Our free cash flow range is now $50 million to $100 million, due to the lower earnings range.

In North America, we have not changed our view of the commercial or residential market opportunity since our last call. That outlook suggests essentially flat to low-single digit growth in the commercial opportunity in the back half of the year. However, we are revising our outlook for Europe down despite the low-single digit volume growth we enjoyed in the second quarter. June data from EUROCONSTUCT which publishes macroeconomic projections we used in our forecasting processes points to more negative trends in non-residential construction for both new and renovation activity than their December 2012 projections, which had informed our previous guidance. Expectations for year-on-year change in critical markets like the UK, France, Germany, Italy, and the Netherlands are all down. This more than offsets positive revisions to countries like Spain, Belgium, and Ireland. We expect China, India, and Southeast Asia to grow faster than what was included in our previous guidance but this is somewhat offset by even a more negative view on Australia.

Slide 15 provides the more detailed assumptions going into our earnings guidance and includes the specifics on the third quarter. We continue to expect annual inflation in the range of $50 million to $60 million, the lion's share of the increase impacting the Wood segment. We continue to target a 2.5% annual improvement in gross manufacturing productivity year over year. However, it's clear we will not hit that in 2013 due to the wood manufacturing productivity challenges Matt described. Our outlook for consolidated adjusted gross margin is now a decline of 100 to 250 basis points on the full year versus last year, down 50 basis points from our last guidance due to the weaker Wood segment margins.

We expect total SG&A as a percent of sales to come in at 15.75% to 16.25%, just up slightly at the mid-point versus 2012 due to our investments in emerging markets. Guidance on the pension credit and earnings from WAVE are unchanged from April. We have tightened our range on cash taxes modestly. Our estimate for the third quarter sales including anticipated FX impacts is a range of $740 million to $780 million. At the mid-point sales would be up over 9% from the third quarter of 2012 when adjusted for the Patriot disposition. We expect to earn $110 million to $130 million of adjusted EBITDA compared to $135 million on a comparable basis in 2012. The adjusted EBITDA estimate is impacted by significant lumber inflation, start-up manufacturing expenses in China, and higher SG&A spend, and our growth platforms including Russia, and architectural specialties.

We are increasing our capital expenditure estimate for the year to $180 million to $200 million, due to the LVT investment that Matt just announced. Lastly, with the WAVE European plant closure costs, we now anticipate $10 million to $15 million associated with cost reduction initiatives. We look forward to catching up with wood demand and inflation and to driving meaningful growth from our emerging market expansion, now that our plant footprint is coming online. And with that, I'll now turn it back to Matt.

Thanks, Tom. While we're disappointed in the timing of the wood recovery and outlook for further weakness in Europe, we're pleased with the top line strength we saw in North America. We're optimistic a commercial recovery may finally be starting, and as we outlined in detail, are confident we've taken the necessary steps to address our Wood segment challenges. We'd like to thank you for your time today and with that, we'd be happy to take any questions.

(Operator Instructions)

Our first question comes from Dennis McGill of Zelman and Associates.

Hello. Thank you very much. The first question is, as it relates to capacity in the Wood business, can you maybe update us on where capacity will stand now, after this last crew was up and running, and how to think about that over the course of the recovery? Then, just as it relates to those hires, can you just discuss a little bit about what you're finding with respect to availability of labor out there, the quality of that labor, the ability to retain the labor after you have it, any kind of color you could put around that. Thanks.

Let me frame it and we'll toss it over to Frank for more details. As the 400 plus new labor employees or new production employees come on line, we expect to have the capacity necessary to drive service levels back to our historical highs, if you will, certainly in the fourth quarter. We think that we'll be able to manage capacity and we'll be at an acceptable capacity, at least capacity standpoint then, and with an acceptable capacity utilization.

In terms of labor, it has been a bit of a challenge. Certainly, early in the recruiting process, we had some challenges in a couple of our plants in terms of stability. That seems to be largely behind us. Availability of labor is tough in some of the places, just given the nature of where our plants are. We tend to be in most of the locations of our wood plants, the largest single employer in the area anyway, so we soaked up a lot of the labor pool just to begin with. Again, we've seen very strong improvement in the trends in the labor productivity and the labor stability. We're confident that we'll be back at the appropriate and competitive service levels in the fourth quarter. Frank, do you have anything to add to that?

No, I think Matt summarized it well, both on the capacity. We'll be in full recovery position in fourth quarter and we anticipate we'd be able to support demand going into 2014 at current market projections. Other than that, I think Matt covered it.

Our next question is from Michael Rehaut of JP Morgan.

Thanks, good afternoon, everyone. My question is with regards to Europe. I believe you mentioned at the end of your prepared remarks that the change in outlook is really driven by a change in forecasts that across all of the different countries in Europe. You went through obviously the different ones. I just wanted to get a little more granular there, but really in terms of, if those forecasts are consistent with what you're actually seeing in the field, in terms of order trends and from your own salesforce, if it's really more the latter that's driving your change in view, rather than the service and the forecast that you're subscribing to.

When we think about an outlook for a market it's a compilation of factors. We certainly consider external sources, EUROCONSTRUCT being a source that we consult regularly. But we also look hard at the third and fourth quarter outlooks from our salesforce. We have a relatively strong enough share position in each of our businesses that we think that reflects real life market dynamics. We look at the loading and backlog and order trends. So, it's a compilation of those things.

Secondly, we are somewhat affected by our relative positions geographically in Europe. As you know in our Building Products business, we're strong in the UK. In our foreign business we have relatively strong positions in central Europe and in the Scandinavian countries. In addition to that, we have a very strong presence in Russia in our Ceilings business, not so much in our flooring business, and both of our businesses have I would say competitive and strong positions and expanding positions in the Middle East which we include in our European results. As a Company, we have very limited exposure to what we would consider traditional Southern Europe, so Italy, France, and Spain. Those numbers change a little bit business by business. Our outlook is a function of certainly external resources, our salesforce, and a grounded forecasting method that we have in both of our businesses, and our geographic presence, our weighting if you will, by geography.

Mike, Tom here. A couple thoughts. First, we did see Europe become weaker in the second quarter and that was in Matt's opening comments. It did come in weaker. Even though we had a pretty good quarter all-in, our Flooring business had actual sales growth in the quarter. And our Ceilings business actually had 7% growth on a constant FX basis. The optics of the second quarter looked pretty good but it was weaker than we expected, largely because we had big jobs shift there. We're not just looking at macro forecasts. Certainly, we had an experience in the second quarter that influenced us here and it triangulated well with the EUROCONSTRUCT. The UK projections are down a good 150 basis points. France is down about 300 basis points on growth rates for commercial forecasts. Both those factors are driving our forecast.

Our next question comes from Nishu Sood of Deutsche Bank.

Thanks. I wanted to also focus in on the Wood Flooring division. Appreciate all of the color and break down of the drivers. Obviously, most of the factors that you were mentioning related to materials and what sorts of materials you're purchasing, and the labor as well are on the cost side. You mentioned that EBITDA margins should be up, I believe, on a year-over-year basis by the fourth quarter. My question related to that is what are the risks you see? Obviously, this has been a volatile time for that business. What are the risks you see to that forecast? Also, most of the discussion was around the impact on margins. Has there been any negative impact on sales as well from the issues that that business has been facing?

All very good questions. To answer the last question first, there's no evidence that our revenue or at least incoming sales have been affected by the service delays. These issues are facing the entire Wood Flooring industry, not just us. Clearly and assuredly, we'll fill these proportional to our share position. But these are challenges that everybody in the Wood Flooring business is facing. The order book remains strong, and so again, we're confident that we're maintaining our share and the revenue outlook should be in pretty good shape.

In terms of risk, we believe we have very robust processes in place. We are micromanaging the actions to address the four issues that we laid out. To the extent there's any risk, I would characterize the risk as more timing than execution. So, in our view, said another way, we don't think it's a matter of if, it might be a matter of when. Having said that, we believe we factored responsibly any sort of timing risks in the outlook that we shared with you guys today. Frank, any additional color?

When we look at green lumber versus PKD, we have seen green lumber receipts come up. This is the time of year that you can get green lumber. We feel very good about where we stand there, PKD versus green. Inflation, as I think Tom and Matt indicated earlier, while at a high level, the rate of increase has slowed down, in some cases, stopped. Seemingly, we found where the ceiling is, so to speak, on inflation. Those two factors are the biggest drivers going forward that we need to see come through. All-in all, I think we've categorized the risk appropriately and I think Matt said it well when he said it's a function of timing versus whether we'll get it or not.

Our next question comes from Ken Zener of KeyBanc Capital Markets.

Afternoon, gentlemen. With so much of your corporate EBIT tied to ceiling systems in the US, can you talk about the increase in volume that we saw in the quarter, as it relates to, I think you guys talked about retail R&R leading the way initially. But can you expand on that as it relates to perhaps seasonal education, healthcare, given that we're seeing positive volume in the US? Thank you.

Yes, just a couple of opening comments and we'll throw it over to Vic. In North America, we actually saw very solid signs of a modest recovery. We're beginning to see some traction in a lot of segments. I would point to the office segment and remodel as holding up relatively well. We're still seeing relative weakness in healthcare and education. Of course, those are both tied to public spending and we haven't seen state budgets healing measurably yet. I think we're going to have to see employment strengthen somewhat more significantly than we have to see the tax revenue drive into the state budgets in that and then finding its way into construction of schools and remodeling of schools. We're still a little cautious there. But we did see relatively strong results in almost every region in the US and across a series of market segments. We think that's mostly market related. Vic?

I think in the opening remarks, we talked about the impact of the Sandy renovation activity up in the Northeast region. We had one region particularly strong and that volume was driven again, due to the Sandy renovation work. As Matt said, we're not seeing any education or healthcare bump. In fact, those starts continue to be negative year-over-year and the volume driven is broad-based as Matt said, and its driven by the office renovation activity for the most part.

I would reiterate just before we close out this one that our Building Products business saw strength in really all regions. We saw it in North America, Europe, and in the Pacific Rim.

Our next question comes from Kathryn Thompson of Thompson Research.

Thanks for taking my questions today. I wanted to take more forward look on demand. In you're prepared comments you noted that global architectural sales were up in the mid-teens which would theoretically imply an acceleration of trends for your non-res focused sales. Could you talk about early Q3 trends in your Ceiling segment related to that? Then also, if you could touch on trends in Wood, given that there has been a lot of focus on the impact of rising interest rates on potential residential demand? And finally, touch on Resilient Flooring too, and any other relevant trends you care to share.

Sure. I mean architectural specialties, we're seeing broad-based strength geographically, Kathryn, architectural specialties. The part of the world that's exceptionally exciting for us right now is the Middle East. The good news is, it's a great market for that. There's some significant projects there and our position is, we feel, we have a very competitive position as we've discussed in the past. There's a drafting effect of a good, strong architectural specialty specification and the fact that it drafts the mineral fiber with it. The tough part about that part of the world is the fact that it's project. So it's binary. You have to bid the project, write the project, and of course, these all have to ship as forecasted. The challenge is a little bit from a calendar perspective on outlooking the revenue. But I would say that we're seeing broad-based strength in architectural specialties. As that segment within Ceilings continues to grow, we're well positioned there. Vic, do you want to comment on that?

No, I think you said it very well. And again, I think we also have a pretty good pipeline of projects in the Americas and in Europe to continue, in addition to the Middle East. I think there is a little bit of momentum to that business, and we should see some continued growth there.

One thing, Kathryn, just one thing to put an exclamation point on it. There's very exciting growth in architectural specialty. We're seeing, we believe, share gain. This is not a signal of incremental demand. This is a result of our intentional investment in the architectural specialty space in all regions of the world that's showing through on the top line and the bottom line for us. Relative to what are we seeing in July, let me just speak a bit about the second quarter and July. Really, the quarter came in largely as we expected in the second quarter which meant a pretty strong April and May and a pretty soft June. That's kind of how we expected it. That's how it came in. That's true across both Flooring and Ceilings in the month of June. But in the month of July, we see it coming back. I think it's going to continue to be choppy. We're going to have signals of strength of demand. We're going to have signals of weakness in demand, and so we're just trying to do our best to discern it. But I'd say June's off to a reasonably good start, but in line with the outlook we've provided on the quarter.

The other comment with respect to Wood, despite some tightening in the financial belt, there doesn't seem to be any softening in the outlook for demand on housing starts. As we said, we're beginning to see a little strength in resi remodels. That'll drive some Wood business, too. We'll see that through the big box channels, so listen, we're keeping an eye on this. Obviously, constantly but currently there just doesn't seem to be any change in that trajectory, and in addition, like we said we're starting to see some strength in remodel. Frank, I don't know if you want to add anything to that.

I think that's well said.

Our next question comes from Stephen Kim of Barclays.

Great, guys. I wanted to ask you a couple questions. I guess a question about your plant openings. If you could, you mentioned about the LVT plant and I guess you took up your CapEx spend about $10 million for this year. Is that going to be the extent of the investment in this LVT plant? If you could talk a little bit more about also what you're expecting from this plant, the kind of ramp up it will provide, and ultimately what you think its run rate might be. Then in China, you mentioned something about the plant there, about because you're starting to produce more locally there, that the customers are holding less inventory. Could you quantify that for us?

Let's talk about the LVT plant first. The $10 million, Stephen, represents the amount of investment in that plant that we anticipate this year. We've got a lot of work to do to finalize things like site selection, engineering, et cetera. We'll be sharing more information on the economics behind the plant and the timing behind the plant as we go into the year. Everything you asked about is somewhat dependent on the first decision we have to make, which is site selection. We're hopeful to have that done shortly and we're hopeful to be able to share more information about that in the third quarter call.

LVT represents a significant growth opportunity for us. We do believe the economics, despite (inaudible) in the US, are compelling, just in terms of the import duty and distribution cost avoidance. It gives us tremendous flexibility from a manufacturing perspective, allows us to maintain less inventory, and frankly gives Frank's team a lot more flexibility around design. We're able to fine tune the products a lot faster. Its margin should improve. [Response] should improve and our ability to innovate improves as well. We're excited about it and again, there's tons to share as we go forward and just wanted to share the fact that the Board supported us for yet another significant investment in manufacturing is looked at, the revenue position of business or the Company for further sales growth in the future. And the second question was?

On China. The impact, of --

Yes, you want to take that, Frank?

I think the question was in China, what was the impact on going local production, versus sourcing. The best way that I can answer that is to tell you when we source products into China, typically the lead time was 12 to 15 weeks. Going local, that's now down to two to three weeks. We cut the supply chain by 70% which then had the significant impact on inventory reduction in the system. That's largely behind us. We knew it would be two- to three-month adjustment of inventory. What we should see going forward is largely the result of demand, supported by local production.

Our next question comes from David MacGregor of Longbow Research.

Hi, good afternoon.

Hi, David.

To follow-up on the LVT question a moment ago, I guess the reason you can't talk about the total available market as these plants have a limited shipping radius. It'll dependent on where you're situated. Is that how we should interpret your answer?

It's a good question, David. No, not at all. I think we've modified our LVT capability in Europe and we're seeing some strength there. But no, this isn't necessarily a factor of geographic limitation. I think what we want to do is make sure we nail down the economics of the plant before we become a little bit more transparent on what we want, how we want to describe the economics. We'll always try to place a plant investment, returns on that investment, in the context of the market. Rather than talk about the market without a plant, we want to put this story together and share it with you in the third quarter. And Frank?

This is Tom. We are expecting this plant to be extremely attractive IRR project. It will be in excess of the plants we've built in the emerging markets, given the North America margin structure. Stephen, to your earlier point, we are expecting about $10 million in the current year just to get going. We're expecting the bulk of the spend to happen in 2014. Again, that's going to depend on the site selection. That's why we're being a little ambiguous here because have to we pick the site and decide do we need a building, do we not need a building? And how fast is can we get going on it to articulate ramp-up speed. But we have framed I think for the Board another very attractive investment, mostly a savings project not dependent on share growth to achieve returns, which I think we've got a great track record of delivering.

And just to reconfirm on what we said earlier on the site selection, this is a North American plant to support the North American market. As we go through site selection, we'll pick the right location in North America, but this plant is not a global plant. This is to support the local North American market and demand.

Our next question comes from George Staphos of Bank of America Merill Lynch.

Thanks, everyone. I wanted to ask a two-part on manufacturing and the outlook. On LVT, from your vantage point, is there anyone else considering adding capacity in luxury vinyl tile in North America? Or do you think you'll be the only new capacity being added and therefore meeting a market that's more attractive than it would be otherwise? Then, the second question I had just in terms of Wood products, do you think that there have been any kind of pre-buying or double booking and current fundamentals that's leading to perhaps a pullback in demand, just when you're ready to produce in the fourth quarter and beyond? Thanks guys? Good luck in the quarter.

Thanks. Two good questions. The first is, to our knowledge, nobody is considering an LVT investment. Of course, it's impossible to be 100% certain. But there's no evidence that anybody else is considering that. Of course, that could change at any time. We don't think an additional investment by our competition, if at all, would change the economics of our product but that'd be something to consider.

In terms of doubling up on wood demand, again, there's no evidence of that going on. Frank's team looks at wholesale to retail sell-through. We look at our residential contractors building schedules. We try to keep an eye on the demand of our customers, as well as the demand from our customers. Again, we try to pressure check this regularly to make sure that we haven't got excessive demand signals in the backlog. But there's really no evidence to suggest that's the case. That's something we look at and monitor all the time.

Our next question comes from Bob Wetenhall of RBC Capital Markets.

Hi, good afternoon.

Hi, Bob.

It sounds like you're guidance suggests that EBIT margin might comp negative in the third quarter in Resilient Flooring and Ceilings. I was wondering if the implied negative comp is just due to the start-up ramp costs you have with the new plants that you've been talking about. If I could sneak one other in, is there any risk to the wood price increase in Flooring? Is that something which is from your perspective in the bag? Thanks a lot. Good luck.

Let me take the wood pricing increasing question first and I'll kick it over to Tom to talk about the EBITDA outlook. At this point, Bob, the most recent price increase hasn't gone into effect yet. But we've been successful in negotiating the historic levels of realization of those price increases. We think demand will continue to be strong in the third and fourth quarter. We think supply will loosen somewhat, but certainly still be relatively tight when you consider it somewhat historically. Again, Frank's team is working very hard with our channel partners in big box and the residential contractors to make sure that we are in a position to continue to serve their demand, and again, they've been successful. It's tough negotiations in being somewhat successful in getting the price. Nothing yet to suggest that the next price increase won't hold, but we aren't there yet.

In terms of the EBITDA and the pressures on EBITDA in the third quarter, Tom?

Yes, Bob, good afternoon. This is Tom. I think you've surmised it correctly. We are ramping up the heterogeneous plant here in the third quarter, so that is one of the three plants starting up, concurrently in the third quarter along with both ceilings and homogeneous plant beginning to achieve the commercialization. We are spending heavily on SG&A in both those segments to deliver against the growth plans of those plants and get the plant start up and through really the start up curves. These plants don't start at full capacity and it'll start in a straight, vertical line. That is correct and this is probably not that different of a third quarter outlook than what we have provided except for the Wood segment. I think relative to the expectation you might have had before, what's changed in the third quarter is much more on the Wood side and a little bit of Europe.

Our next question comes from Mike Wood of Macquarie.

Hi, thank you. You mentioned the green lumber receipts are up. Is this seasonal? Or is supply finally starting to catch up? And if you could just talk also about what your expectations embedded for the price inflation in wood for the fourth quarter. Does it subside like framing lumber has, or is it flat from current levels?

Mike, the answer to your question, answer to the first part of your question is both. There's certainly a seasonal component to getting the wood. There's a weather dimension, et cetera. We do see steady improvement in green lumber availability. You've got capacity coming online and seasonality. That says that the improvements we're seeing should be sustainable, and certainly the drying sheds in our hardwood flooring plants are certainly a lot more full than they were in the first quarter.

In terms of inflation in the outlook, as we think about the balance of the year, as we pointed out in the comments, I think Frank will back this up, we see it settling in at higher than historical levels, but it appears to be leveling off. There's nothing that suggests that's going to peak up again. But again, like so many other things on this one, we watch it all the time. There's no evidence to suggest at this point, there's no stimulus to suggest, it should increase but we watch it all the time. Tom, anything?

No, I think you've covered it. Our outlook on the year assumes that it's plateauing here and we've priced for the plateau. So, that's built into our outlook.

Our next question comes from Will Randow of Citigroup.

Hi. Good afternoon and thanks for taking my question. A question on the balance sheet. It looks like you brought leverage down to about half a turn on net debt-to-EBITDA basis, year-on-year, as well as you expect to build about a dollar per share in cash from free cash flow. How are you thinking about capital deployment outside of the plant you mentioned? Any room for special dividends or anything of that nature?

Thank you for the question, Will. This is Tom. Obviously, we're always keeping our eye on the balance sheet. We have framed a range as you know of two to three times net debt-to-EBITDA as our target range. And yes, at the end of the second quarter we're at 2.0 basically on net debt-to-EBITDA range, so we're coming in at the low end of the range. We've never said as soon as we hit the bottom of the threshold, we're going to do something automatically. We obviously evaluate capital deployment against other alternatives out there, like acquisitions or organic capital expansion. We'll continue to dialogue it over here with no announcement today, obviously, on a dividend or other deployment. Certainly we are cognizant that we are, through our cash generation and earnings growth, that we're projecting this year and through our mid-cycle guidance. We'll be de-levering quickly and want to look for smart ways to deploy that.

Thanks for that.

Our next question comes from John Baugh of Stifel Nicolaus.

Thank you, good afternoon. Just a quick question on the Wood segment if I could. The mix erosion you alluded to, and building being strong. I assume that's something that's going to continue going forward. Could you discuss how mix plays into your guidance? Then, I think you made a reference to being back to mid-2012 EBIT ranges by the fourth quarter. I just wanted to make sure what that number was. Thank you.

Sure. I'll comment on the mix dynamics and then Tom or Frank can comment on the margins. The mix dynamic is really a function of the customer segment strength. As you might imagine, you've got the strength coming out of the blocks was residential contractors. So, you're dealing with base layer product at that point. We'll continue to see that demand remain but the mix increase or improvement we see comes from big box. We would see our two large big box channels delivering improved mix over that as remodel improves and just the sell-through from them improves. As they come on stronger, we expect the mix to move in the right direction. But it's purely a function of customer segment dynamics.

John, on the margin, you heard correctly. Our plans for that improved mix, for the pricing catching up with the inflation, and the improvement in Wood productivity should yield a Q4 EBIT margin that gets to, what I'll call mid-2012 EBIT margins. And you can go back and look you'll see. It was a hair over 11% on an EBIT margin basis. We're obviously well below that in the current quarter.

Our next question comes from Jim Barrett of CL King and Associates.

Good afternoon. This is a question for either Matt or Vic. To what degree does the second half guidance incorporate your August price increase in ceilings in the US being successful? Could you comment on that?

Yes, this is Matt. We've had a track record the last couple of years of getting strong yield from those price increases. There's nothing that suggests that we will fail to get our historical yield from the announced price increase. When Vic's team puts together the outlook for the forecast, they factored in historical price increase yield on that. Vic, anything?

No, that's well said.

Okay, well thank you very much.

Our next question is a follow-up from Nishu Sood of Deutsche Bank.

Thanks. I wanted to ask more specifically about the sales guidance for the third quarter. The $740 million, I believe it was, to $780 million. With sales in the first and second quarter having come in where you've expected, you continue to expect this acceleration into the back half of the year. I was wondering if you could break that down for us geographically. Since you're saying Europe is maybe a little bit weaker, does that imply greater than expected trajectory in North America? Also, divisionally I was wondering if you could break it down, whether the relative sales strength we've seen in the first half of the year will persist into the second half.

Okay, in terms of geographics that we are expecting continue strengthen the North American business. If you look at our Ceilings business, we're modestly optimistic at a modest commercial recovery. We would continue to describe the environment as choppy, but we like what we see in the second half. Clearly on the Flooring side of the business, we'll see Resilient Flooring maintain a flattish outlook. But the Wood business will continue to be extremely strong. As we go on the other side of the supply versus demand issues, we're going to see our ability to supply that demand go up significantly as these 400 labor and production employees come on line and become more productive.

Europe is a mixed bag. We've got some benefit of some timing in the first half. We expect to see continued strengthening in the Russian market and a little help in architectural specialties in the Middle East. In the Pacific Rim, we'll see relative strength in China and India. In both businesses, we'll continue to expect an outlook of relatively weak Australia. Tom?

Yes, maybe a little bit more building up from ground zero here on the blocks. We've been taking huge pricing in both businesses. On a year-on-year basis, we'll have all the wood pricing kicking in. Our last announced increase is effective middle of July. That's cumulative on top of the other increases we've taken. We've got the ceilings price increase beginning of August effective and also similarly they took a price increase in February. We've had significant pricing in the Americas kicking in. That's a big contributor. Secondly, we continue to expect the strength of volume demand by new construction in Wood. So, you take those two things and then you also back out the fact that we will be anniversarying in August our Patriot divestiture which has been a drag for the prior three quarters. We will not have that as significant of a drag there. I think that's how we get confident around the level of sales growth that we've seen and that also help drive the sales growth we enjoyed in the second quarter.

Our next question comes from David MacGregor of Longbow Research.

Yes, just a follow-up. I wonder if you could talk about your third quarter guidance, and specifically, total plant start-up expenses that you have in that number.

Yes, David, we haven't guided on a quarterly level how the plant expenses are. On a full year basis, we've told folks we expect to be $10 million to $15 million of plant start-up expense and another $5 million to $10 million of SG&A expense, associated with the emerging market plant start-ups. We haven't put that on a quarter-by-quarter basis, so that's about as specific as we've gotten on that.

With no further questions at this time, I'd like to turn the conference back over to Mr. Matt Espe for any closing remarks.

Okay. On behalf of everybody here, we appreciate your interest this afternoon and your questions. We've got our work cut out for us, certainly in the Wood business. We're confident that we've got the right actions in place and we're tracking appropriately. We feel that everywhere around the world, Armstrong is positioned to take advantage of a strong market, if it occurs, or continue to win in challenging markets, if that be the case. Thank you very much. Have a great day.

Ladies and gentlemen, this does conclude today's conference. You may all disconnect and have a wonderful day.